Govt finances need to improve for policy rate cuts

The Reserve Bank of India (RBI) on Tuesday said it will be “constrained” from lowering the policy rate, which is critical to accelerate growth in the domestic economy, unless the government puts in place a credible fiscal consolidation plan.

The central bank kept its policy rate steady for the second time in as many months despite fears of slow economic growth gaining credence and inflation moderating.

“Strong signs of fiscal consolidation, which would shift the balance of aggregate demand from public to private and from consumption to capital formation, are critical to creating space for lowering the policy rate without imminent risk of resurgent inflation....The forthcoming Union Budget must exploit the opportunity to begin this process in a credible and sustainable way,” RBI said.

RBI warned higher fiscal deficit, which has been elevated since 2008-09, may crowd out credit to the private sector and pose upside risks to inflation. The government had earlier said fiscal deficit would remain at 4.6 per cent of gross domestic product (GDP) in the current financial year.

“If the increase in government borrowing already announced is an indication, the gross fiscal deficit for 2011-12 will overshoot the Budget estimate substantially,” the central bank said.

The government had announced an increase in borrowings through dated securities of about Rs 53,000 crore in September, and an additional Rs 40,000 crore in December. The revised gross borrowings for the year are now estimated at around Rs 5.1 lakh crore. “Fiscal consolidation has to come from both increasing revenue flows and compressing expenditure....As much as we understand the government’s compulsion, I think fiscal consolidation is important for the medium term sustainability of the macro economy and for growth prospects,” said RBI governor D Subbarao.

He added the government should give an indication of its constraints and opportunities in managing the fiscal position. “Some large items of the Budget are non-discretionary expenditure, like salaries, pensions and interest payments. So, the government can put out what the discretionary expenditure items are, and how it is going to roll out next year and beyond. Then, the fiscal deficit numbers, which are being contemplated in the medium term, are actually flashed out in some detail, about how they would actually materialise. That would be credible,” he added.

RBI also favoured a revision in domestic administered prices of coal and petroleum products, though such a move is expected to increase inflationary pressures. It said such revisions were necessary to maintain the balance between demand and supply.

“As the food subsidy bill is expected to rise, it will be prudent to fully deregulate diesel prices to contain both aggregate demand and trade deficit,” RBI said.

In its third-quarter review of monetary policy for 2011-12, the banking regulator cut its GDP growth forecast for the current financial year from 7.6 per cent to seven per cent. The weak global macro economic environment, the slow industrial output, the shrinking investment and a deceleration in resource flow to the commercial sector prompted RBI to pare its growth outlook.

The central bank expects modest recovery in the domestic economy in 2012-13, with growth being “slightly faster” than that in the current financial year.